How to Pay Down Massive Debt: A Realistic Approach

You’ve probably heard the stories of how a $90,000 debt was paid off in just 3 years. Or a $115,000 debt was paid down in just 2.5 years. While these are certainly inspiring events, they’re not very realistic for most people. Usually, to pay off such large sums of debt in a short amount of time, drastic measures are taken: three jobs, no extra spending whatsoever, and sometimes even having to cut back on proper nutrition.

So, then, how does someone pay off a massive debt realistically?

I’ll define what I mean by massive. If you’ve got $3000 in credit card debt and can afford to pay back more than the monthly minimum, then it’s likely you can pay that debt off on your own. But, what do you do if you owe a lot of debt? What if you have $20,000 or even $40,000 in debt and earn a salary of $45,000 a year? What are your debt relief solutions then? That’s what I’ll be examining more deeply in today’s podcast.

There are many people in Ontario who have a very high debt load. The reason? They just don’t make enough to pay off what they owe.

My average client has a household income that is over 40% less than the median household income in Ontario.

Now, you might be thinking that they’re just overspending and living the high life. But that’s a popular misconception. The truth is, Canadians with large levels of debt experience an increase in the amount of money they owe because they’re caught in a debt trap. The more debt they have, the more interest they pay and the less of their income they have to live on. Their temporary solution? Use more debt to make ends meet. Eventually, they’re caught in a debt cycle that can’t stop without the drastic measures I mentioned earlier: a second job and severe cutbacks on expenses. For some people, even those steps aren’t enough to be debt free.

So, what are your options to pay back a massive debt?

The first thing I recommend is to define the enemy.

When it comes to tackling your unsecured debt, there are a few things you can try:

Take a close look at your big secured debt items. Are your monthly secured debt (mortgage, car) payments so high that you’re unable to make ends meet? If so, I’d highly recommend either handing back the expensive car or selling your home to find a cheaper option. Try to hit the reset button on your budget. If that’s not enough,

See if a debt consolidation loan with lower interest can help. With this option, your monthly payments might be lowered enough to let you avoid borrowing to make ends meet. However, this type of loan won’t lower your debt overall. It only extends your repayment period. You’ll still have to pay a significant amount in interest over time. For some Canadians, this option may still not be enough to allow them to pay back a massive debt load. As an example, if you owe $60,000 and the bank allows five years to pay it off, you’ll still be paying nearly $1400 a month, which is challenging if you only net $2400 per month. For many debtors in Ontario, that’s their average take-home pay, according to our Hoyes Michalos Joe Debtor bankruptcy study.

Find out if a debt management program (DMP) will lower your payments enough. A not-for-profit credit counsellor can help you create a debt management plan, in which you repay your debt in full, but with little or no interest. However if you have massive debt, though, say, $60,000, you’re still having to pay a little over $1000 a month, which again, isn’t doable for many people.

If you realize that you can’t become debt free with the choices outlined above, you might benefit from learning more about bankruptcy. This debt relief option was created to give ‘honest, but unfortunate debtors’ a fresh financial start. Your first step will be to meet with a Licensed Insolvency Trustee, who will carefully analyze your financial situation and explain all of your debt relief options. One of the main benefits of bankruptcy is immediate protection. Your creditors will not be allowed to sue you or even contact you. The cost of bankruptcy will depend on your income, assets, and how long you’ll be bankrupt. You’ll be able to keep basic household items, an inexpensive car, and even your RRSP investments that you’ve had for over a year.

In addition to bankruptcy, there’s another debt relief method that most people aren’t aware of and that can also help you get rid of massive debt. It’s called a consumer proposal. With a consumer proposal, you get to keep all of your assets, make small monthly payments, and receive immediate legal protection from your creditors.

To learn more about how both bankruptcy and consumer proposals can help you pay off a large debt load, tune in to the podcast.

FULL TRANSCRIPT – SHOW #178 How to Pay Down Massive Debt: A Realistic Approach

Doug Hoyes:

The media and finance bloggers love stories where people pay off their massive student and credit card debt in short periods of time. You’ve probably read the headlines – “How I paid off $90,000 in debt in 3 years” or this one – “I managed to pay off $80,000 in auto, credit card, and student loans debt in just over three years.”

Some are a little more realistic like the story of Rachel Gause who “with a whole lot of determination and almost a decade’s worth of belt-tightening” paid off $160,000 in debt.

Those stories of people paying off massive debts in 2 years or 3 years are inspiring but for most people it’s just not reality.

If you owe $5,000 on a credit card, stop using it, and pay more than the minimum balance each month, eventually you will be out of debt. It’s highly likely that you can repay that level of debt on your own.

But what if you owe more than $5,000? What if you owe $10,000 or even $50,000 in non-mortgage debt?

What if you have a massive amount of debt?

That’s the topic for discussion on today’s Technical Tidbits edition of Debt Free in 30.

What do I mean when I say “massive” amounts of debt?

It’s different for everyone. If you owe $100,000 on credit cards but you earn a million dollars a year, you can service your debts, so it’s not a massive amount for you. If you just got laid off from your job, $10,000 may be a massive amount of debt, because you can’t make even your minimum payments.

That’s the key point: your debt is massive if you can’t pay it.

Personal finance experts will tell you to “cut your expenses, get a second job, sell some assets, you can do it!”, and I agree, those are excellent steps to take, but that won’t be enough if your debt is massive.

We know from our Joe Debtor study that the average amount of unsecured debt owing by someone who files a bankruptcy or consumer proposal with Hoyes Michalos was just over $52,000 when we did a detailed analysis of the numbers a year ago.

That varies by city.

In London it’s around $45,000, in Windsor it’s around $46,000, Kitchener is about $48,000, Guelph and Oshawa are about $55,000, the City of Toronto is about $57,000, Mississauga is $67,000, and the Orangeville area is a staggering $86,000 in unsecured debt owed by people who file a consumer proposal or bankruptcy with Hoyes Michalos.

Those amounts don’t include mortgages or car loans; that’s just unsecured debt like credit cards, unsecured lines of credit and bank loans, payday loans, student loans and income taxes.

You can see how your town compares by visiting hoyes.com/debtmap/if you are interested.

But you get my point. There are a lot of Ontarians out there with massive amounts of debt.

So why can’t they just tighten their belts, follow the common “11 tips for paying off more than $100,000 in debt”, make and succeed at their own debt repayment plan?

The reason is quite simple and it’s one my clients experience every day. Their income just isn’t high enough to service their debts.

My average client has a household income that is over 40% less than the median household income in Ontario. They don’t have enough money coming in, so they can’t pay their debts.

Yes, there are those with higher incomes, but they still can’t service the debt they have. They are insolvent.

Why am I sharing these numbers?

Because the public has a misconception that people could get out of debt if they would just work harder, if they would just be more disciplined.

If your only debt is a $5,000 credit card, that’s probably true, but my average client has a take-home pay of less than $2,400 per month.

Do the math; if you owe $52,000, and your minimum payments are 3% plus interest, even at just 12% interest that’s $2000 a month in minimum payments.

It is impossible to earn $2,400 and make payments of $2,000 per month and still pay rent and buy food.

And that brings me to another popular misconception (as you can see I like breaking myths). People with massive debt didn’t get there because they were living the high life. Sure, that happens, but it’s rare. People with massive debt levels saw their debt levels grow over time because they were caught in a debt trap. As their interest payments grows, interest consumes an ever-increasing share of their household income. So, what do they do? They take on more debt to pay the bills. For most, much of their debt was borrowing money to pay interest on old debt. Their massive debt levels have them caught in a debt cycle they can’t break without something much more radical than cutting back on expenses or working a part time job.

What do you do if you have more debt than you can possibly ever repay?

What do you do if you have a massive amount of debt?

The first thing I recommend is to define the enemy. If your budget is out of balance because your mortgage or car payments are too high, then you need to consider eliminating that problem first. Even if you get rid of your current credit card debt, without taking a hard look at how it all began, the cycle will continue. If you can afford to keep up with your mortgage and car payments after eliminating your other debts, great. If not, seriously consider selling your existing home, handing back that expensive car, and finding a cheaper option. If it’s overspending, deal with that.

Once you have hit the reset button on your budget, it’s time to tackle your debt.

You could see if a lower-interest debt consolidation loan will lower your payments enough to allow you to stop borrowing more money to make ends meet.

The problem is, if you have too much debt already and don’t have substantial equity in your home, you likely won’t qualify for a debt consolidation loan.

I also caution people taking this approach to realize that a debt consolidation loan does not reduce your debt. It just lowers your payments but prolongs the repayment period. You are still paying a substantial amount of money in interest over time.

And for some, this option still isn’t enough to solve the problem. If the bank agrees to give you five years to pay off your $52,000 loan, your monthly payments are still going to be almost $1,200 a month. That’s not doable if you are netting $2,400 per month.

If you own your home (and can afford it) you may be able to consolidate your credit card debt into a second mortgage or home equity line of credit. The ability to spread your payments out with your mortgage over 15-20 years may lower your monthly payment enough to balance your budget, but you will be in debt for a long time. And if real estate prices drop, you can find yourself with more mortgage than home value, which may affect your ability to renew down the road.

So, what about credit counsellors? Don’t they have a program to help people get out of debt? Yes, and it’s called a debt management plan. In a DMP, you repay all of your debts in full, and they can generally reduce or eliminate any interest.

But if your debt is massive, that may not be enough either. On $52,000 in debt you will be paying almost $900 a month. For many people that’s still not affordable.

And by the way – back to myth busting. A debt repayment program through a not-for-profit credit counselling agency has the same impact on your credit as a repayment plan filed with a Licensed Insolvency Trustee. Doing a deal with a credit counsellor will still appear on your credit report.

Something else typically happens when you have massive unsecured debt. You owe lots of creditors, you might be getting collection calls or be threatened with a wage garnishment. A debt management plan through a credit counselling agency won’t deal with all creditors (Revenue Canada and payday loans are typical examples), can’t legally stop a wage garnishment and isn’t binding on all your creditors whether one or two agree or not.

So now we’ve determined that you can’t afford a debt consolidation loan, you can’t afford a debt management plan, or it won’t work for your debts, so what’s left?

There are only two legally binding strategies to eliminate your unsecured debt – personal bankruptcy or a consumer proposal through a Licensed Insolvency Trustee like Hoyes Michalos.

Even in these good economic times, almost 40,000 people file insolvency in Ontario every year. After the recession in 2009 almost 67,000 insolvencies were filed in Ontario. The Bankruptcy & Insolvency Act was made for exactly your situation if you have massive debt. The purpose of the Bankruptcy & Insolvency Act is to give the ‘honest but unfortunate debtor’ a ‘fresh start’. It makes no sense to require someone to continue to live under the burden of excessive debt. Eventually they run out of borrowing options. Without a safety valve like bankruptcy or a consumer proposal, they would have no way out.

So back to those options.

Filing bankruptcy starts with a meeting with a licensed insolvency trustee. We assess your situation and explain your options (including the ones I talked about above). And there’s another myth: if you talk to a licensed insolvency trustee we don’t only talk bankruptcy. We are required by law to explain all your options. Our goal is to help you deal with your massive debt problem. If another solution makes most sense, we’ll tell you that. If you have significant equity in your home, we’ll suggest talking to a mortgage broker. If credit counselling is better for you, we’ll refer you to a local reputable credit counsellor.

From the moment you file bankruptcy, the people you owe money to are not allowed to sue you, or even call you; they must deal with the licensed insolvency trustee.

The cost of a bankruptcy varies depending on your income, what assets you own and how long you will be bankrupt. Each month you will send us a budget, which determines how much you contribute towards your debts. The more you earn, the more you repay to your creditors. However, when you have massive debts, your bankruptcy payments will be much less than you are paying now.

Most bankruptcies last nine months but can last longer if you were bankrupt before, if you have higher income, or if there are unusual aspects to your situation. You also lose the value of certain investments and other assets, but most of the people we do bankruptcies for don’t have any valuable assets. You get to keep your basic household stuff, an inexpensive car, and even any money that has been in your RRSP for more than a year.

There will be a note on your credit report for approximately 7 years, but since you had so much debt you couldn’t borrow anyway, that’s not really a big deal.

Your debts are gone, you get a fresh start, and once the bankruptcy is over, in as little as nine months, you can start rebuilding your credit.

Bankruptcy used to be the most common solution for people with massive debts, but that is no longer the case.

Most people don’t know this, but in Ontario more people choose a different legal solution to deal with massive debt loads: a consumer proposal.

A consumer proposal is not bankruptcy; you don’t lose your assets, and you don’t have to send in a monthly budget, and if your income goes up your payments don’t change.

You don’t have any of the disadvantages of a bankruptcy, but you get the same big benefit you get in a bankruptcy: protection from your creditors.

So, what is a consumer proposal?

A consumer proposal is a deal.

If you owe $50,000, a typical deal might be that you pay $250 or $300 per month for five years. The exact amount depends on who you owe money to, and what you earn, but in general in a typical consumer proposal you end up making payments that are about a third of your debt, with no interest.

Like a debt management plan, a consumer proposal will appear on your credit report. Again, if you are filing a consumer proposal you probably can’t borrow money at good rates already, so by eliminating your debts you are improving your future credit score.

I’ve had hundreds of clients over the years who filed a proposal, and after it was done, and after they started saving money and taking steps to rebuild their credit, they were able to buy a car, or house, or start saving for their retirement.

Let’s recap with a look at our ‘average’ $52,000 debtor.

He could keep paying his debts on his own however he can’t afford his $2,000 monthly minimum payments, and is unlikely to get out of debt by continuing along this path.

He could try a debt consolidation loan, but his monthly payments would still be around $1,200, so he can’t afford that either.

He could talk to a credit counsellor about a debt management plan, but even $900 a month is unaffordable, and he has too many creditors to deal with through a DMP.

He could file a consumer proposal and make a deal with all his creditors. His cost might be in the range of $250 – $300 a month.

As a last resort, he could file bankruptcy.

There is no one right answer for anyone however in most cases where you have massive debt levels a bankruptcy or proposal is the most viable alternative.

Eliminating the burden of debt is truly a fresh start.

Debt won’t go away on its own, so if you have massive debt, consider talking to a Licensed Insolvency Trustee about these options.

That’s our show for today.

Full show notes, including a full transcript and links to the pros and cons of bankruptcy and consumer proposals can be found at hoyes.com, that’s hoyes.com.

I’ve got some interesting shows coming up in February with some big announcements and some brand new guests, so please subscribe on iTunes, or Stitcher, or Spotify, Google Play, or wherever you get your podcasts; I release a new episode every Saturday morning by 8:00 am.

Thanks for listening, until next week, I’m Doug Hoyes, that was Debt Free in 30.